NEW YORK ( TheStreet) -- Shares of Discover Financial Services ( DFS) should trade at a much higher multiple to forward earnings estimates and as a result are considerably undervalued by the market, according to William Blair analyst Robert Napoli.

Napoli upgraded Discover to "outperform" from "market perform," saying in a report on Wednesday that the "shares should trade in the mid-$50 range, or about 13 times our conservative 2015 EPS estimate of $4.23, which we consider "normalized earnings," versus the current valuation of 9.6 times on 2015 EPS." Such a valuation implies roughly 35-40% upside in the shares.

Discover's shares were up 5% year-to-date through Tuesday's close, following a 63% return during 2012. But "the valuation still does not give credit for the true franchise value and the proven strength of the management team," Napoli wrote.

A quick look at Discover's very strong earnings performance illustrates just how low the forward price-to-earnings ratio is.

For fiscal 2012 ended Nov. 30, the credit card lender reported net income available to common stockholders of $2.3 billion, or $4.47 a share, increasing from $2.2 billion, or $4.06 a share, the previous year. The company's return on average assets (ROA) was 3.23% in fiscal 2012, and its return on average tangible common equity (ROTCE) was 26.8%, according to Thomson Reuters Bank Insight.

With its focus on credit card lending, Discover's ROA has ranged from 1.20% to 3.43% over the past five fiscal years, while the ROTCE has ranged from 12.7% to 26.8%. During that period, the "weak year" for ROTCE was fiscal 2010, when Discover set aside $3.2 billion for loan loss reserves.

The low forward P/E ratio puts Discover's stock at a similar valuation to the "big four" U.S. banks, which lack Discover's focus on credit card loans. Such loans made up 82% of the Discover's loan portfolio as of Nov 30.

Shares of Citigroup (C) closed at $43.60 Monday, trading for 8.4 times the consensus 2014 EPS estimate of $5.20. Excluding 2008, when Citi lost $27.7 billion, the company's ROTCE has ranged from negative 1.33% to 8.04% over the past four years, according to Thomson Reuters Bank Insight.

Bank of America (BAC) closed at $11.55 Tuesday, trading for 9.0 times the consensus 2014 EPS estimate of $1.29. The company's ROTCE over the past five years has ranged from a negative 1.75% to 8.20%.

JPMorgan Chase (JPM) closed at $49.49 Tuesday, trading for 8.5 times the consensus 2014 EPS estimate of $5.82. The company's ROTCE over the past five years has ranged from 6.89% to 15.26%.

Shares of Wells Fargo (WFC) closed at $35.88 Tuesday, trading for 9.2 times the consensus 2014 EPS estimate of $3.89. Wells Fargo has had the best earnings among the big four, with ROTCE ranging from 8.97% to 18.02% over the past five years.

Despite his upgrade, Napoli believes Discover is "overearning." He points to "credit losses at an all-time low and margins at attractive levels," and believes the company will build its loan loss reserves over the next several years. The analyst estimates that Discover will earn $4.56 during fiscal 2013, with earnings declining slightly to $4.50 in fiscal 2014, declining further to a "normalized" level of $4.23 in fiscal 2015.

Major growth initiatives for Discover include the company's partnership with eBay ( EBAY) unit PayPal and the company's new "It" card, which Napoli said "will likely represent the largest marketing investment in 2013.

The "It" card "provides the combination of solid features (e.g., rewards, strong customer service) without fees and will serve as Discover's flagship card for customer acquisitions," according to Napoli, and is meant to compete against similar products, including Capital One ( COF) Cash Rewards, Bank of America Cash Rewards, Chase Freedom and Citi Simplicity.

"Discover has employed several strategies over the years to drive controlled growth. We believe this has allowed Discover to have some of the best credit metrics in the industry during the recession and next to best metrics currently," Napoli wrote.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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